Invest in deposits or government bonds to earn a risk-free rate of return (time value of money);

Take on various market and factor risks to earn the respective risk premia (betas);

Find inefficiencies and dislocations in markets and capture this excess returns (alpha).

Noviscient specialises in sourcing alpha, the time-varying pockets of inefficiencies in the markets that can be profitably exploited. To access alpha you need to be in the right place at the right time with the right skills. Alpha is NOT undiscovered beta. Alpha profits come from leveraging technical skills to exploit market inefficiencies, whilst betas are the premia received for bearing systematic (non-diversifiable) risks.

Alpha and beta are fundamentally different. They are not fungible. They can and ought to be considered separately.

Beta exposures will increasingly be sourced by large asset managers such as Vanguard and Blackrock who are efficient at providing these beta exposures for investors. These exposures are available in low-cost products such as ETFs, where investors are ‘paid’ the risk premium for bearing systemic risk, whether that is the market crashing or volatility blowing up. Because betas are abundant and easily available, investors shouldn’t pay a high fee for it.

Alpha strategies, on the other hand, benefit from mispricings and inefficiencies in the financial markets. Since they are uncorrelated with the broader markets, they carry minimal market risks and greatly enhance the diversification benefits in any investment portfolio. This makes alpha very attractive – if you can find it.

At Noviscient, our focus is purely on alpha. We are constantly looking for and building a pool of genuine alpha-generating trading firms to create pure alpha products for our investors. We think deeply about the sources of alpha. This is what we have learned:

Alpha is rare and difficult to find so we need sophisticated identification technologies;

Competition for alpha is intense and time-sensitive as alpha decays so we need to be able to access it quickly and efficiently;

Exploiting alpha often requires expensive capabilities so we need a robust execution and risk infrastructure to help defray costs.

We spent the last three years building a platform focused on these three requirements to be able to offer investors scalable access to alpha from all around the world.

Finding Alpha

So, how do you find alpha? Well, alpha doesn’t lend itself to easy solutions. You can’t find alpha by simply applying an algorithm – that would be too easy. The answer lies is variation and selection. Extensive experimentation is required to select the ones that actually work (out of sample or going forward).

Two broad approaches to variation and selection are: brute force and science.

Brute Force

Brute force is Darwinian in that you randomly vary (or mutate) strategies and the ones that are better suited to the environment (that is, those which generate consistent profits) survive. This is crowd-sourcing – often tried by aspiring traders with only technical skills. While one may try to be creative with ideas and strategy generation, the lack of expert domain knowledge has proven to generate short-lived success at best.

Science

The science equivalent of the brute force variation and selection is conjecture and experiment. Conjecture leverages existing domain knowledge of markets and products to infer possibilities, which are then scientifically or rigorously tested. This approach is far more promising. It suggests that the smarter path to alpha is finding groups that combine market and product knowledge with creative conjecture and the technical skills to run their experiments efficiently.

Noviscient works with hedge funds and trading groups that demonstrate capabilities in conjecture and experiment. They are our scientific heroes. We overlay our external validation and selection capabilities on their alpha strategies wrapped in a fee structure that ensures alignment with our investors. The result is a pure alpha product that generates attractive and positive returns in all conditions, even the current one.

The Challenge

Traded markets are huge – around US$100 trillion in AUM. There are thousands of financial products available out there. All these products have their own risks, returns and interdependence characteristics. How can anyone be expected to invest in any reasonable manner?

Which products will improve my return and reduce my risk?

How do these products complement my existing portfolio?

How do their returns correlate with each other?

How do things change as the broader market environment changes?

What the investors often end up with is a suboptimal investment portfolio.

What do investors really want?

As investors, we don’t want products. It is too hard to interpret and assess them all. What we want are solutions that meet our needs given the investment opportunities and the current state of the markets. But where do we get these solutions?

Not from bankers whose interests are more aligned with recommending products that maximize their fee revenues rather than my investment performance.

Not from robo-advisors that only ever seems to suggest the same set of ETFs.

Not from my neighbor with the CFA who quite likely has an investment portfolio that is in worse shape than mine.

What is the answer?

Guidance from technically competent financial intermediaries with deep domain knowledge, strong technical skills operating within an aligned and transparent framework. These groups will need to perform the following functions:

Interpreting the market – filter all those thousands of products to find the small set of products that dominate all the other products. Then model these products to understand their risk and return characteristics, likely in terms of factors, as well as their dependencies.

Understanding your position and preferences – characterize your current investments and your future goals and liabilities.